David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies The Estée Lauder Companies Inc. (NYSE:EL) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Estée Lauder Companies

What Is Estée Lauder Companies's Net Debt?

As you can see below, Estée Lauder Companies had US$5.51b of debt, at June 2022, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has US$3.98b in cash leading to net debt of about US$1.53b.

How Strong Is Estée Lauder Companies' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Estée Lauder Companies had liabilities of US$5.82b due within 12 months and liabilities of US$8.66b due beyond that. Offsetting these obligations, it had cash of US$3.98b as well as receivables valued at US$1.63b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$8.87b.

Given Estée Lauder Companies has a humongous market capitalization of US$83.8b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Estée Lauder Companies's net debt is only 0.36 times its EBITDA. And its EBIT easily covers its interest expense, being 25.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Estée Lauder Companies grew its EBIT at 18% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Estée Lauder Companies's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Estée Lauder Companies recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Estée Lauder Companies's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Estée Lauder Companies is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Estée Lauder Companies .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.